Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
The purpose of this paper is to describe the implementation of value stream management and lean accounting at Watlow Electric Manufacturing Company. Value stream management and lean accounting are designed to support lean manufacturing where value is defined from the customer's perspective, work is organized by value stream, supply flow is defined in terms of demand pull, and employees are empowered and focused on quality and continuous improvement.
Value Stream Management
Rather than organizing by functional departments (i.e., the traditional approach associated with responsibility accounting1), a company using value stream management develops an organization structure based on value streams, where a value stream includes everything involved in creating value for a customer, e.g., everything associated with a product or product line. Value streams tend to include the work of many functional areas such as product design, production, marketing, sales, distribution, and cash collection. Metrics, or measurements are created for each value stream. Some examples used by Watlow Electric include: safety (case incident rate), quality (defects per million), delivery (on-time to promise percentage), cost (sales per full-time equivalent), and inventory (days of inventory). Standard costs, cost allocations, and variance analysis are not used. Instead, only "directly incurred costs" are used for decisions related to the value streams.
Their Steps to Implementation
1. Identified the main types of value streams. These include demand creation, new product development, and order fulfillment value streams.2
2. Identified measurements for the different levels within the company including enterprise level, individual division/site level, value stream level, and cell level. The frequency of the measurements is different at the various levels. For example, enterprise and site level measurements are developed monthly, value stream level measurements are reported weekly, and cell level measurements tend to be provided on a daily basis.
3. Developed three or four value streams per site that include between 25 to 150 people.3
4. Developed value stream financial statements focused on a one-page summary called a box score.
5. Changed the chart of accounts structure to focus on a few value stream groups, rather than functional departments.
6. Stopped collecting standard cost labor and overhead variance information and replaced it with visual live hourly and daily operator-generated reports acted on daily by the value stream teams.
7. Separated materials costs from other conversion costs and emphasized inventory purchases in internal financial statements.
The functional departments that remain have been combined into a general support group in the general ledger. This has been resisted by some, but has greatly reduced the number of ledger accounts.
Although fully burdened standard costs are no longer used, standard materials costs are based on a detailed bill of materials, and inventory is valued at the end of the month at average conversion cost per day multiplied by the number of days of inventory on hand.
Many employees displayed some apprehension at first when responsibility shifted from department managers to value stream members, but they rapidly took ownership of their value stream measurements.
The changes in inventory costing were a concern to product managers who were responsible for pricing decisions, but they were trained to utilize market-based pricing, rather than cost-plus pricing.
Decisions are now made by value stream teams rather than by functions or department managers. Sales and production people work together in value stream teams as opposed to the old approach where sales threw opportunities over-the-wall to production without considering capacity and other constraints. Sales and operations planning have been tailored to value stream capacity. This enhanced cooperation between sales and production has resulted in an increase in sales by more than 15%.
Future steps include a focus on simplifying and eliminating unnecessary steps and transactions in the production process to drive out waste, using more visual controls, developing better pull based materials flows (kanban techniques4), and designing process flows with adequate internal controls.
For more information related to value stream management and lean accounting, see What is lean accounting?
1 See MAAW's responsibility accounting section for more on the traditional organization structure. Critics refer to it as the stovepipe organization.
2 For an example of an order fulfillment value stream, see Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part I. Journal of Cost Management (March/April): 23-27. (Summary).
3 Humans socialize in groups, but a natural limit referred to as the "social channel capacity" determines the maximum number of individuals with whom we can have a genuine social relationship. Robin Dunbar calculates a measurement referred to as the neocortex ratio of a particular species which relates to the size of the brain. For humans the ratio is approximately 150. See The Tipping Point summary for more on the power of context.
4 See MAAW's Just-in-Time section for more on the kanban technique, manufacturing cells and related concepts.
Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part I. Journal of Cost Management (March/April): 23-27. (Summary).
Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part II. Journal of Cost Management (May/June): 24-30. (Summary).
Kapanowski, G. 2016. Lean fundamentals for accountants. Cost Management (January/February): 5-14. (Summary).
Kapanowski, G. 2017. Lean accounting. Cost Management (January/February): 37-41. (Summary).
Kristensen, T. B. and P. Israelsen 2012. Management accounting system problems in context of lean: Development of a proposed solution. In Mitchell, F., H. Norrreklit and M. Jakobsen, eds. 2012. The Routledge Companion to Cost Management. Routledge Companions in Business. (Summary).
Martin, J. R. Not dated. Lean concepts and terms. Management And Accounting Web. https://maaw.info/LeanConceptsandTermsSummary.htm
Martin, J. R. Not dated. What is lean accounting? Management And Accounting Web. https://maaw.info/LeanAccounting.htm
Pickering, M. 2017. Implementing lean management reporting in lean enterprises. Cost Management (January/February): 28-36. (Summary).
Swank, C. K. 2003. The lean service machine. Harvard Business Review (October): 123-129. (Summary).
Vollmann, T. 1990. Changing manufacturing performance measurements. Proceedings of the Third Annual Management Accounting Symposium. Sarasota: American Accounting Association: 53-62. (Summary).